IRS Asks Organizations Seeking Charity Status to Supply More Details

As the number of groups seeking charity status has soared in the past decade, the Internal Revenue Service has struggled to keep up. More than 90,000 groups applied for charity status in 2003, the most recent year for which data are available, up from about 60,000 in 1993.

Even though demand for tax exemptions has been growing steadily, the IRS says that in the past two years more than 10 percent of the people who handle applications for tax-exempt status have quit their jobs or retired — and the tax agency has not had enough money to replace them. What’s more, IRS officials acknowledge that the agency’s computer systems and methods for collecting information are sorely outdated. As a result, it often takes the agency more than three months, on average, to decide whether a group will receive an exemption from paying federal taxes, IRS officials say. That process is expected to take even longer in coming months, because the IRS now asks groups that apply for charity status to provide far more information than in the past.

The changes come as members of Congress are asking tough questions about whether the IRS and other federal agencies do enough to crack down on nonprofit organizations that provide undue financial benefits to their founders, donors, top officials, and others. The IRS says it hopes that a more rigorous review of charities at the application stage will make it easier to punish groups that abuse their tax-exempt status, and prevent the start-up of organizations that don’t have serious charitable intentions.

“The information we get from organizations at an early stage can materially improve our enforcement ability,” says Martha Sullivan, the head of the tax agency’s exempt-organizations office. “We can take much earlier action against potential schemes or abuses.”

New Application Form

Organizations seeking tax-exempt status now have the option of filling out an old version of the federal application form, known as Form 1023, or using a new one that was unveiled in October. Starting in May, however, all organizations will be required to use the new form. The IRS warns that the new form will take organizations more time to fill out — perhaps 50 percent more, some tax experts estimate.

On the revised tax form, which added a dozen questions to the 47 already asked, organizations must submit data about their payments to third parties that helped create them. The goal of providing that information is to enable the IRS to uncover instances in which people illegally benefit from their connections to charities.

Groups also must start providing detailed information justifying the salaries they pay their officials. In addition, organizations must turn over information about their relationships with employees’ businesses and family members, and explain their conflict-of-interest practices.

Concerns About Staffing

While the revised form offers more information that could be useful in enforcement of the tax laws, it is unclear whether the tax agency has sufficient staff to make good use of the data. In the past year, the IRS has hired more than 70 new auditors to examine tax-exempt organizations, its first substantial increase in a decade. Over all, the revenue service now has 290 auditors to investigate potential abuses at more than 1.6 million charities and other tax-exempt organizations.

It is also not clear whether the IRS will use its revised form to guard the tax-exemption door more closely. It currently rejects just 1 percent of applications, a figure that has not changed much during the past decade. Organizations are denied charity status for various reasons, such as failing to submit a complete application.

The IRS has no plans to hire new employees to handle the applications for tax-exempt status, Ms. Sullivan says. She wants the division to improve its turnaround time for applications by starting to use technology more effectively. For example, clerks now type into computer databases information included on applications. Scanning forms, or processing them electronically, could help the agency save time and money, Ms. Sullivan says. (A team of IRS employees is currently working to create an online charity application. Ms. Sullivan said she does not know when such a form will be available.)

Ms. Sullivan also wants to persuade the IRS to start using the same databases to keep track of new charities and those groups that get audited. Currently, she says, information about new charities and groups that have been audited is stored in two different places.

Missing Data

The biggest delays in the charity-application process stem from a requirement that many organizations do not know about when they draft their articles of incorporation, says Cindy M. Westcott, who is in charge of the tax agency’s determinations facility, in Cincinnati. All groups must include in their articles of incorporation specific language that explains what will happen if the group is ever forced to shut down. The IRS says charities must show specifically how assets they control will continue to be used for a charitable purpose, even after an organization dissolves.

The IRS has tried to persuade state officials to remind charities to include this information when they are established. But many groups still do not get the message and must amend their articles of incorporation — a process that often involves gathering their boards of directors and can take several months, according to Ms. Westcott.

Problems in which applicants fail to provide required technical information occur with more than 40 percent of applications, Ms. Westcott says. Those applicants often require four or more follow-up contacts before they fully comply. IRS officials hope that the revised form will allow them to cut their follow-up correspondence in half.

Other applications get delayed because the IRS requests data that groups have already supplied on another part of the form, some lawyers say. Ms. Westcott says the IRS has been guilty of that — as well as of requesting information that is not necessary to complete an application.

For example, in the past, she says, an application might have been delayed because an organization failed to fill in every block on the form.

“If someone didn’t check a block but provided information that gives us the answer,” Ms. Westcott says, “it shouldn’t be necessary to send back a page.”

The revised Form 1023 is available online at http://www.irs.gov.

Printed copies of the form can be obtained by calling the IRS at (800) 829-3676.